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Diversification to reflect uncertainty

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People like their investment advice delivered in small bite-size chunks. It's commonly advised to reduce risk by diversifying your portfolio, and this indeed makes sense a lot of the time. For example if you invest your entire savings in one stock and that company goes bankrupt then you lose everything - it's akin to putting everything on black in a game of roulette.

We live in a probabilistic world

Quantum physicists say that they can't predict where subatomic particles will be from moment to moment, they can just tell us the probability of where they'll be. Even in a Newtonian world, we could only predict where things would be in an hour's time if we had knowledge of the exact status of the world right now - including the status of predictions of what's going on in people's brains - an impossible ask unless your name is God. So, it is clear that where the world is going from moment to moment, including the economic world, is far from certain. In a world where people crave certainty, the best us humans can do is work on probabilities. And in fact, in the investment world, we don't even know what the probabilities are, we just have hunches based on our expertise and experience.

An insightful investor acknowledges the areas where there are greater and lesser degrees of uncertainty. Avoid investment professionals who speak about certainties - guarantees from companies depend on whether the companies are able to honour them, banks sometimes go bankrupt and even governments are known to default on their obligations.

When should you concentrate your bets?

The degree of concentration of one's bets should reflect the degree of certainty one has in their outcome relative to one's investment objectives, compared to the expected outcome of other bets. For example, if there is 100% certainty (which we know there never is) that a certain investment will outperform everything else, then everything should be invested in that investment. If you have no idea which investment will outperform, then it makes sense to spread one's bets. As Warren Buffett said, "Diversification is protection against ignorance".

Focus on your investment goal

Of course the probability of outperformance should be measured relative to one's investment goal. The strategy which maximises the probability of saving R100,000 in 3 years time to pay for your kids university, is usually different to the strategy which maximises the probability of retiring comfortably in 40 years time.

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